1. The Basic Model
   1. External events involve an exchange between the company and another entity; internal transactions do not involve an exchange transaction but do affect financial position.
   2. The accounting equation underlies the process used to capture the effect of economic events (transactions):
      Assets = Liabilities + Owners' Equity
   3. Each transaction has a dual effect on the accounting equation.
   4.  Owners' equity for a corporation, called shareholders' equity, is classified by source as either paid-in capital or retained earnings.
   5. The double-entry system is used to process transactions.
      1. Elements of the accounting equation are represented by accounts in a general ledger.
      2. In the double-entry system, debit means left side of an account, and credit means right side of an account.
      3. Asset increases are entered on the debit side of accounts and decreases are entered on the credit side. Liability and equity account increases are credits and decreases are debits.  Here is a graphic illustrating the process.
      
      
2.  The Accounting Processing Cycle
   1. Step 1. Obtain information about transactions from source documents.
   2. Step 2. Transaction analysis is the process of reviewing source documents to determine the dual effect on the accounting equation and the specific elements involved.  Illustration
   3. Step 3. Record the transaction in a journal. For most external transactions, special journals (discussed in Appendix 2C) are used to capture the dual effect of the transaction in debit/credit form.  Illustration
   4. Step 4. Post from the journal to the general ledger accounts. In addition to general ledger control accounts, a subsidiary ledger (discussed in Appendix 2C) contains a group of subsidiary accounts associated with particular general ledger control accounts.  Illustration

5. Step 5.  Prepare an unadjusted trial balance. A spreadsheet (discussed in Appendix 2A) can be utilized as a tool after and instead of step 5 in the processing cycle.
3.  Adjusting Entries
1. Step 6. Record adjusting entries and post to the ledger accounts.
2. Prepayments are transactions in which the cash flow precedes expense of revenue recognition.
   1.  Prepaid expenses represent assets recorded when a cash disbursement creates benefits beyond the current reporting period.  Illustration
   2.  Unearned revenues represent liabilities recorded when cash is received from customers in advance of providing a good or service.  Illustration
3. Accruals involve transactions where the cash outflow or inflow takes place in a period subsequent to expense or revenue recognition.
   1.  Accrued liabilities represent liabilities recorded when an expense has been incurred prior to cash payment.  Illustration
   2.  Accrued receivables involve situations when the revenue is earned in a period prior to the cash receipt.  Illustration
4. Estimates often are made to comply with the accrual accounting model.
   1. Most estimates involve either prepayments or accruals.
   2. One situation involving an estimate that does not fit neatly into either the prepayment or accrual classification is bad debt expense.
5. Step 7. Preparation of an adjusted trial balance.
6. Accountants sometimes use reversing entries (discussed in Appendix 2B) in conjunction with adjusting entries.


4. Step 8. Prepare Financial Statements
1.  The income statement
2.  The balance sheet

3.  The statement of cash flows
4.  The statement of shareholders' equity
5. Step 9. Close the Temporary Accounts  Illustration
1. Close the revenue accounts to income summary.
2. Close the expense accounts to income summary.
3. Close the income summary account to retained earnings.
4. Step 10. Prepare a  post-closing trial balance.

6.  Conversion from Cash Basis to Accrual Basis
1. Add (deduct) increases (decreases) in assets. For example, an increase in accounts receivable means that the company earned more revenue than cash collected.
2. Add (deduct) decreases (increases) in accrued liabilities. For example, a decrease in interest payable means that the company incurred less interest expense than the cash interest paid, requiring the addition to cash basis-income.

 Here is a quiz to test your understanding of this chapter.